Advantages and Disadvantages of Incorporating
Taking a closer look at the process of incorporation.
A corporation is defined as a legal entity or structure created under
the authority of the laws of a state consisting of a person or group of persons
who become shareholders. The entity's existence is considered separate and
distinct from that of its members. Like a real person, a corporation can enter
into contracts; sue and be sued; pay taxes separately from its owners; and do
the other things necessary to conduct business.
Incorporation can be a complicated process. Take into consideration the
advantages and disadvantages listed below before you embark on incorporating
your company.
Advantages
- Limited Liability. One
of the key reasons for forming a corporation is the limited liability
protection provided to its owners. Because a corporation is considered a
separate legal entity, the shareholders have limited liability for the
corporation's debts. The personal assets of shareholders are not at risk
for satisfying corporate debts or liabilities.
- Corporate Tax Treatment.
Since a corporation is a separate legal entity, it pays taxes separate and
apart from its owners (at least in the typical C corporation). Owners of a
corporation only pay taxes on corporate profits paid to them in the form
of salaries, bonuses and dividends. The corporation pays taxes, at the
corporate rate, on any profits.
- Attractive Investment.
The built-in stock structure of a corporation makes it attractive to
investors.
- Capital Incentive. The
stock structure also allows corporations to attract key and talented
employees by offering an ownership interest in the form of stock options
or stock.
- Owner/Employee. A
business owner who works in his or her own business may become an employee
and thus be eligible for reimbursement or deduction of many types of
expenses, including health and life insurance.
- Operational Structure.
Corporations have a set management structure. Shareholders are the owners
of a corporation, who elect a Board of Directors, which then elects the
officers. Other than the election of directors, shareholders do not
typically participate in the operations of the corporation. The Board of
Directors is responsible for the management of and exercising the rights
and responsibilities of a corporation. The Board sets corporate policy and
the strategy for the corporation. The Board elects officers, usually a
CEO, vice president, treasurer and secretary, to follow the policies set
by the Board and manage the corporation on a day-to-day basis. In a small
corporation, the lines between the shareholders, Board of Directors and
officers tends to blur because the same people may be serving in all
capacities.
- Perpetual Existence. A
corporation continues to exist until the shareholders decide to dissolve
it or merge with another business.
- Freely Transferable Shares.
Shares of corporations are generally freely transferrable because as a
separate entity, the existence of a corporation is not dependent upon who
the owners or investors are at any one time. A corporation continues to
exist as a separate entity and is not terminated or dissolved even when
shareholders die or sell their shares. Shares of corporations are freely
transferrable unless shareholders have "buy-sell" agreements
limiting when and to whom shares may be sold or transferred. Also, securities
laws may restrict the transferability of shares.
Disadvantages
- Fees. It costs money to
incorporate. There are typically four types of fees, including: a fee to
file the articles of incorporation with the secretary of state; a first
year franchise tax prepayment; fees for various governmental filings; and
attorney fees. But every year tens of thousands of businesses choose to
incorporate online without the use of an attorney. For example, basic
incorporation before filing fees at a site like LegalZoom.com costs just $99.
- Formalities. The proper
corporate formalities of organizing and running a corporation must be followed in order to receive the benefits of being a corporation.
- Paperwork. A huge
aspect of the corporate formalities that must be followed consists of
paperwork. Reports and tax returns must be compiled and filed in a timely
fashion; business bank accounts and records must be maintained and kept
separate from personal accounts and assets; records must be kept of
corporate actions, including meetings of shareholders and Board of
Directors; and licenses must be maintained.
- Disclosure of Names of
Corporate Officers and Directors. Most states do not require that names
of shareholders be a matter of public record; however, many states require
that the names and addresses of corporate officers and directors be listed
on one or more documents filed with the Secretary of State.
- Dissolution. Since
corporations have a perpetual existence, states provide a mechanism for
dissolving a corporation and liquidating its assets. Dissolution does not
happen automatically. A corporation can be dissolved voluntarily or
involuntarily. A corporation's officers and directors are charged with
responsibility for dissolving the corporation, including gathering
corporate assets, paying creditors and outstanding claims, and
distributing remaining assets to shareholders.
- Tax Consequences. C
corporations have potential double tax consequences—once when the company
makes its profit, and a second time when dividends are paid to
shareholders. S corporations can mitigate this tax issue.
If you are ready to incorporate now and do not need to use a lawyer, check out LegalZoom.com
or another online incorporation service.